GS Finance’s $1.6 million absolute return trigger notes on S&P aimed at conservative bears

By Emma Trincal

New York, March 4 – GS Finance Corp.’s $1.6 million of 0% absolute return trigger index-linked notes linked to the S&P 500 index due Feb. 25, 2027 offer full principal protection and excess return in a negative stock market, making the product best suited for bears looking to implement their view with less risk, advisers said.

If on any day during the life of the notes the index closes down 30% or above 30% of its initial level, investors will receive par plus 12.5% at maturity, according to a 424B2 filing with the Securities and Exchange Commission.

If the index stays within the range of 70% to 130% of its initial level during the life of the notes, investors will receive par plus the absolute value of the index return.

Shark note

“A shark note! We’ve seen them come through,” said Ken Nuttall, chief investment officer of BlackDiamond Wealth Management.

“I don’t like them. They’re trying to give you growth and income and you get neither one of them.

“If the index is up 29.9% you get capped at 12.5%.

“Your 12.5% is 4% a year. It’s a money market rate with the possibility of getting 10%.”

The term “shark” designates a principal-protected note with a lower and upper barrier observed daily, such as this one. Investors participate in the absolute return if the underlying stays within the range but get either par or par plus a bonus (as is the case here with the 12.5% fixed payment) when there is a barrier breach. The term “shark” refers to the fin-like shape of the payout diagram when the payout drops upon the breach.

“We thought of it. We’ve seen a few recently. But if I want income, I can do an autocall and if I want growth, I’m not going to settle for 10% a year,” said Nuttall.

Playing it safe

This adviser recently purchased a five-year note on the S&P 500 Futures Excess Return index with 2.34 times the upside, no cap and an 80% barrier.

“That’s a growth note,” he said.

“What you’re looking at here is a super conservative type of play. Your principal is protected. But you’re not going to make money on this.

“If you’re really conservative, do a T-Bill with a 5% yield.”

Small growth

Whether the note was a growth or income product was “debatable,” he said.

“It’s not really an income play because you’re not guaranteed any income. You could get 0%. Even if you get 12%, that’s only 4% a year. Again, I would think you’re better off with a Treasury,” he said.

Nuttall said he would categorize the note as a growth product due to the equity-linked component.

“If you breach one of the two barriers, your growth is limited to 12% on a three year. The index is up 31% at some point and you end up with 12%, or 4% a year. That’s not growth, but technically it is because it’s a participation note within the range,” he said.

Bearish bet

A financial adviser said the notes were for very conservative clients.

“You have to be conservative and bearish,” he said.

When evaluating a structured note, this adviser normally assesses the probabilities of return outcomes using back-testing analysis over rolling periods. In this case, his methodology would not properly apply since the barrier is observed daily and not point to point, he noted.

“It’s all I have so I’m going to use my three-year rolling periods on the S&P anyway. It’s not totally accurate but it will give me an idea,” he said.

Below minus 30%

The first scenario he measured was the breach of the lower barrier, which generates the 12.5% return at maturity. According to his statistics, the lower barrier observed point to point on three-year rolling periods would be breached only 2.6% of the time.

“Assuming the index drops more than 30%, you get 12.5%, which means you outperform the market. The index is down 40% you get 12.5%,” he said.

“If you’re a bear, it’s a smart, safe way to bet against the market. Shorting the S&P or buying an inverse ETF would not give you any protection. But here, you have it.”

Above plus 30%

Less favorable would be the breach of the upper barrier. On a point-to-point observation, such setup would occur 46.1% of the time.

“Now that’s what you have to be concerned about. The index is up more than 30% and you’re stuck with a 12.5% return. You would be lagging the index a lot. That would not be a good thing.

“Almost half of the time, you’re going to underperform. And this is a point-to-point probability. If you observe the breach on any trading day, if you take volatility into consideration, the chances of breaching over 30% should be higher,” he said.

The note was more bearish than bullish because investors would outperform whenever the market was negative and underperform when it rose above the higher barrier.

But those results were far from perfect, he said, since his back-testing data only took under consideration final performance, not daily prices.

“Regardless of the exact probability, if you breach the upper barrier, you’ve locked yourself with a 4% annual return. That’s a very poor result,” he said.

In the range

The last scenario, which is when the index stays within the -30% to +30% range during the entire term, offered mixed results. Investors would outperform on the downside thanks to the absolute return. But they would only market perform on the positive side of the range, or between 0% and 30%.

“This is when the index performance matters the most. If you end up at +5% at maturity, that’s going to be a very low return. Even if you’re down 5% and outperform, it’s still a low return on an absolute basis,” he said.

Volatility and market direction would matter as long as the price stayed above the lower barrier.

“The lower the index decline, the greater the outperformance,” he said.

The notes would outperform in any negative market, underperform if the market rose above 30% and market perform between 0% and +30%, he concluded.

Missing the cycle

“This is very well suited for a bear. If the market is down, you take little to no risk and you beat the pants of the market,” he said.

“But if the market is up, you’ll underperform or be long the market.”

For this adviser, “astute” investors with a bearish outlook should use other strategies.

He suggested one.

“If the stock market is down 25% this year, you sell bonds, you raise cash and you put your money in the stock market.

“But here you’re locked in. At best you’ll make 10% a year. You can’t move your money for three years. Your hands are tied.”

The size of the deal suggested that it had been customized for a single buyer, he said.

“I can’t really get excited about this note. It was probably done for a specific reason or for a specific client. The vast majority of my clients would not have any use for it,” he said.

The notes will be guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes settled on Feb. 27.

The Cusip number is 40057YD75.

The fee is 1%.

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